Andy McNish – who is a partner in our corporate department, looks at buying a franchise…

With redundancies at a high, many people are looking at what self-employed options are open to them and one of the most popular ways to set up a business is by operating a franchise. However, it can be a difficult process, with the first question being ‘what exactly is a franchise’? Well, a franchise agreement allows a person or a company (‘the franchisee’) to trade under the name of another (‘the franchisor’) and most franchise systems operate on a territory basis that are often delineated by postcodes. The most famous franchise business is ‘McDonalds’.

One of the key advantages of having a franchise is that a franchisee can take advantage of the franchisor’s national advertising, purchasing power, name, reputation and training. That means set up costs can be lower and less capital and effort are needed to be put into promoting the business and establishing supply chains.

If you are concerned about your business or management skills – or are wishing to enter an area in which you are inexperienced – then a franchise will allow you to build skills in a low risk environment. Statistic show that established franchises have a lower risk of failure than other types of businesses.

As expected, these advantages come at a cost as franchisees will be expected to pay royalties and can use only the franchisor’s nominated suppliers who themselves will often be paying a commission. There may also be additional fees such as the licensing of any mandatory IT software or contributions to the advertising budget. These can all add up and significantly increase running costs which ultimately reduces profit margins.

There is also less flexibility, as franchisors will provide strict guidelines as to how the franchise should be run. Some business owners may find this level of control to be frustrating and restrictive, but any deviation from the criteria set out potentially puts you in breach of the franchise agreement. This could mean that the franchisor could take away the franchise without paying any compensation.

When it comes to buying a franchise there are a couple of avenues; you can either take a fresh franchise, which is usually for a new territory, or you can purchase an up and running business from a current franchisee.

If you go for the first option, then time and effort will have to be put in by you into building up the business. This should be the lower cost option but it will also be higher risk as you won’t have any actual turnover or profit figures to look at when you are deciding whether to go ahead. If you buy a tried and tested outlet then you will incur higher costs as you will have to pay for the franchise and negotiate a sale agreement with the seller. A purchase of an existing franchise will also need approval of the franchisor.

Sale documents will need to be agreed several days in advance of any target completion date to allow time for the franchisor’s approval. In any event, a new set of the franchise documents – and a new lease if the franchisor is also to be your landlord – will need to be signed.

The franchisor will also often charge fees both to the incoming franchisee (standard set–up costs) and the outgoing one which is based on a % of the sale price – this is usually around 5%. They will also pass on all of their legal costs. Seller’s should also note that that the courts routinely uphold restrictions on an ex-franchisee’s ability to start-up or work in competing businesses for at least a year following sale.

If you think you might be interested in either buying or selling a franchise (or in setting up a franchise network for your existing business) then contact Andy